Sterling fell 3 percent against the dollar to below $1.09, its lowest since 1985, after British Chancellor Kwasi Kwarteng took a huge political risk with a debt-financed £45bn tax cut package .
Britain’s biggest tax cut in 50 years includes a 45p reduction in top-up tax for the highest paid, as well as a sharp cut in dividend levies.
But concerns about the amount of debt needed to finance tax cuts and billions of pounds in energy subsidies have seen the cost of borrowing rise sharply a pound dropped to a 37-year low.
“The UK is behaving a bit like an emerging market, turning itself into a sinking market,” former US Treasury Secretary Larry Summers told Bloomberg. “Britain will be remembered for having the worst macroeconomic policy of any major country for a long time.”
The Institute for Fiscal Studies predicts that government borrowing will top £190bn this year, the third-highest peak since the Second World War, and will remain above £110bn by 2026-27, ensuring the public debt burden will continue to grow.
Additional borrowing is much more expensive for the government than before, with two-year borrowing costs rising to 3.9 percent from 0.4 percent a year ago as investors sold off UK government bonds.
The chancellor bet on the political fortunes of the Conservatives, suggesting that radical tax cuts and deregulation would lift Britain’s weak growth rate to 2.5 percent.
“This is a new approach for a new, growth-focused era,” Kwarteng told MPs to a chorus of Tory cheers and jeers from the Labor benches.
Unlike previous big tax cuts in the 1980s, Kwarteng will borrow tens of billions of pounds to finance his plans, boosting demand at a time when the Bank of England stands increasing interest rates to bring inflation under control.
Paul Johnson, director of the IFS, said: “The plan seems to be to borrow large sums at increasingly expensive rates, put the national debt on an unsustainable growth path and hope we get better growth.”
The National Institute for Economic and Social Research said the UK’s recession will now be shorter and smaller than feared because of the extra borrowing. But to keep inflation under control, the Bank of England will have to raise interest rates to 5 percent and keep them there until at least 2024.
The basic rate of income tax will be cut from 20p in the pound to 19p next April, and national insurance will be cut, as will taxes on dividends. To help first-time buyers, stamp duty will be reduced and a planned rise in corporation tax will be scrapped.
The income tax cut means a person earning £200,000 could save almost £4,500 a year in 2023-24 compared to 2022-23. A worker on a salary of £20,000 will save £218.
The total cost of tax cuts by 2026-27 will be almost £45bn. Kwarteng told MPs in a statement to the House of Commons that his aim was to turn “the vicious cycle of stagnation into a virtuous cycle of growth”.
The chancellor’s package combines tax cuts with a raft of supply-side reforms that he admits may be unpopular in the short term; he insisted he would “unashamedly” advocate for growth.
However, he admitted that the transformation of the UK’s growth outlook “will not happen overnight”. Time is of the essence for Liz Truss’ new government, which took office only this month, with elections expected in 2024.
Anticipating criticism that he was giving too much help to the wealthy, Kwarteng reminded MPs that the government was stepping in to rein in electricity bills for homes and businesses. He said the cost of the energy package would be £60 billion in the first six months.
Quarteng has confirmed it is lifting the cap on bankers’ bonuses, a move aimed at making the City of London more competitive but leaves the Conservatives open to claims from Labor that it is still “the party of the rich”.
Meanwhile, his lifting of a ban on shale gas fracking and a promised overhaul of environmental laws to speed up infrastructure projects have angered the green lobby.
Labor leader Sir Keir Starmer sees his borrowing – which comes at a time when the cost of servicing the national debt is soaring – as a key moment as Starmer looks to take on the mantle of fiscal responsibility at the next election.
Rachel Reeves, the shadow chancellor, described the mini-budget as the Tory government’s “last ditch effort” after “12 years of economic failure”. She warned that government borrowing was too high once interest rates rose.
Among other measures announced by Kvarteng, corporate tax rates will remain at 19 percent, but he will keep the 8 percent levy on bank profits, which was due to be cut next year.
The government’s fiscal rules, which stipulate that debt must decline as a share of gross domestic product within three years, will be revised. “We will publish a medium-term financial plan in due course,” Kwarteng said.
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